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Monday, December 20, 2010

Tax Deductions for Charities

In the current system, strictly speaking, your eligibility to deduct a charitable contribution doesn’t depend on whether you have a big mortgage. But it might as well. You can deduct charitable contributions only if you itemize rather than take the standard deduction, and the most common way a household collects enough deductions to make itemizing worthwhile is to have a big mortgage. (Living in a high-tax city like New York can also help a taxpayer cross that threshold, because state and local taxes are deductible, at least for now.)

But I challenge anyone to justify a system in which we essentially subsidize contributions made by people with big mortgages. For one thing, this set-up magnifies the already large distortion created by the mortgage interest subsidy, since having a mortgage qualifies taxpayers for other subsidies as well.

I think there is a bit more logic to current policy than Thaler does. Suppose you believe, as I do, that consumption is a better tax base than is income. Then, starting with a measurement of income, it makes sense to allow deductions for "non-consumed income"--specifically, saving such as IRA and 401k contributions and charitable giving.

All of this begs the question: Why start with a measure of income rather than consumption? If it is better to tax consumption, why not just tax consumption? Initially, it might have been easier to tax income (by deducting the money from the paycheck), but that's not so clear now.

One caveat: In practice, we shouldn't tax consumption directly unless we want both consumption and income taxes. We already have a bureaucracy devoted to the collection (and verification) of income taxes, and I suspect those bureaucrats like their jobs. In this case, the income tax bureaucracy is a concentrated interest group with all the incentive in the world to stick around. This fact would make it tricky to switch to consumption taxes while guaranteeing the elimination of income taxes.**All of this presumes that consumption is the right base. To the extent that there is disagreement about this premise, it would be even more difficult to come up with a coherent policy.